RIIO regulatory framework
Ofgem’s regulatory framework is known as RIIO (Revenue = Incentives + Innovation + Outputs). The RIIO model offers network companies incentives for securing investment and driving innovation. This ensures the delivery of sustainable energy networks at the lowest cost for current and future customers.
The current RIIO period (T1) runs to April 2021. When consultations begin for RIIO T2, you can find up-to-date details on our Talking Networks website.
Under RIIO the outputs we deliver are clearly articulated and are integrally linked to the calculation of our allowed revenue. These outputs have been determined through an extensive consultation process, which has given stakeholders a greater opportunity to influence the decisions.
The output categories are:
Safety: ensuring the provision of a safe energy network.
Reliability (and availability): promoting networks capable of delivering long-term reliability, minimising the number and duration of interruptions experienced over the price control period, and ensuring adaptation to climate change.
Environmental impact: encouraging companies to play their role in achieving broader environmental objectives–specifically, facilitating the reduction of carbon emissions–as well as minimising their own carbon footprint.
Customer and stakeholder satisfaction: maintaining high levels of customer satisfaction and stakeholder engagement, and improving service levels.
Customer connections: encouraging networks to connect customers quickly and efficiently.
Within each of these output categories are a number of primary and secondary deliverables, reflecting what our stakeholders want us to deliver over the remaining price control period. The nature and number of these deliverables vary according to the output category, with some being linked directly to our allowed revenue, some linked to legislation, and others having only a reputational impact.
Ofgem, using the information we have submitted, along with independent assessments, determines the efficient level of expected costs necessary to deliver them. Under RIIO this is known as totex, which is a component of total allowable expenditure and is the sum of what was defined in previous price controls as operating expenditure (opex) and capital expenditure (capex).
A number of assumptions are necessary for setting these outputs, such as certain prices or the volumes of work that will be needed. Consequently, there are a number of uncertainty mechanisms within the RIIO framework that can result in adjustments to totex if actual prices or volumes differ from the assumptions. These mechanisms protect us and our customers from windfall gains and losses.
Where we under- or over-spend the allowed totex for reasons that are not covered by uncertainty mechanisms, there is a sharing factor. This means the under- or over-spend is shared between us and customers through an adjustment to allowed revenues in future years. This sharing factor provides an incentive for us to provide the outputs efficiently, as we are able to keep a portion of savings we make, with the remainder benefitting our customers.
This sharing factor is one of the ways that RIIO has given innovation more prominence. Innovation includes traditional areas such as new technologies, as well as the broader challenge of finding new ways of working to deliver outputs more efficiently. This broader challenge has an impact on everyone in our business.
Allowed revenue to fund totex costs is split between fast and slow money – a concept under RIIO, based on a specified percentage that is fixed for the duration of the price control. Fast money represents the amount of totex we are able to recover in the next available year. Slow money is added to our RAV – effectively the regulatory IOU. In addition to fast money, in each year we are allowed to recover a portion of the RAV (regulatory depreciation) and a return on the outstanding RAV balance.
The asset life for regulatory depreciation in electricity transmission spans 45 years across the RIIO period. We are also allowed to collect additional revenues related to non-controllable costs and incentives.
The incentive mechanisms can increase or decrease our allowed revenue and result from our performance against various measures related to our outputs. RIIO has incentive mechanisms that encourage us to align our objectives with those of our customers and other stakeholders. For example, performance against our customer satisfaction targets can have a positive or negative effect of up to 1% of allowed annual revenues. Most of our incentives affect our revenues two years after the year of performance.
During the eight year period of the price control, our regulator included a provision for a potential mid-period review, with scope driven by:
changes to outputs that can be justified by clear changes in government policy; and
the introduction of new outputs that are needed to meet the needs of consumers and other network users.
The mid-period review focused on three specific areas, all of which relate to National Grid’s transmission outputs (both gas and electricity).
Under the RIIO controls, we are required to deliver agreed outputs for consumers and are funded to cover the costs of delivering these. The eight-year price control includes a number of uncertainty mechanisms to take account of the fact that some outputs and funding cannot be set with certainty at the start of the period.